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Mighty Morgan

December 22, 1991

Cover Story

MIGHTY MORGAN

During the late 1980s, the venerable J. P. Morgan & Co., a preeminent power in banking almost since its founding by John Pierpont Morgan in 1861, was widely thought to be dead in the water. Compared with rivals, then eagerly building up their loan portfolios, the bank appeared to have become a sluggish also-ran. Critics said Morgan was too set in its pinstriped ways to survive the rough and tumble of the changing financial marketplace.

Today, the House of Morgan has recaptured much of its former glory. While rivals are reeling from lousy loans and struggling to replenish their capital, Morgan is stronger than ever. Morgan Guaranty Trust, Morgan's primary banking subsidiary, is the only big U. S. bank to retain an AAA from credit-rating firms. Its capital cushion is the envy of the industry. And Morgan, the nation's third largest bank, is reporting solid earnings -- up an astonishing 79% in the third quarter, making it the most profitable major U. S. bank. For the full year, some analysts say earnings could approach $1.4 billion, up 36% over 1990.

While other major banks, notably Citicorp, are retrenching, Morgan is expanding both its overseas and U. S. operations. Last May, to cite just one in a recent flurry of international deals, Morgan underwrote the first bond offering for a private Latin American company since the Third World debt crisis began in 1982, a $425 million private placement and Eurobond issue for Cementos Mexicanos, the Mexican cement maker.

Morgan's current success, however, is the product not of a mere revitalization but of a complete remaking, even redefinition, of the institution. Morgan has transformed itself from a conventional commercial bank into a European-style universal bank, combining commercial and investment banking and trading functions. Analysts now view Morgan as one of a handful of firms that will dominate global finance in the 1990s.

Typically, Morgan accomplished this transformation with little fanfare. Yet in an unprecedented series of interviews with BUSINESS WEEK, usually reticent Morgan executives conceded that the process was long and painful, to the point that some questioned whether the bank was making serious mistakes along the way. Some at Morgan were disturbed by the bank's decision to stay on the sidelines while other big banks rushed into seemingly lucrative real estate and leveraged buyout loans -- a move that at the time hurt the bank's earnings but now looks farsighted.

At the same time, competing banks and Wall Street firms contended that Morgan had lost its edge. "It was worrisome," says Morgan's Chairman and Chief Executive Dennis Weatherstone, recalling those bleak days. "But we were building for the future. We had to tough it out."

Especially controversial was the belief by Morgan executives that the bank could become a tougher competitor while preserving what executives term its "values," which emphasize teamwork, capital strength, fastidious attention to client needs, a long-term approach to strategy, and, above all, tradition. Says one former executive: "There's a sense that there really was a Mr. Morgan."

OVERSEAS PUSH. Old J. P. would have been proud of how Morgan's strategy is working. The Cemex issue is only one of several splashy international loans Morgan has arranged lately. In October, Kuwait asked Morgan to arrange a $5.5 billion loan to help pay off war debts. Saudi Arabia reportedly asked Morgan to arrange a similar $3.5 billion credit earlier in the year, though neither the bank nor the Saudis have confirmed it.

Dealmaking is only part of its overseas push. Morgan is now the only institution that is a primary government bond dealer in all seven major industrialized countries. One-third of the bank's professional staff are non-U. S. nationals, while three of its top five executives are foreign-born. Weatherstone himself is a native of London. "I don't think anyone is as strong globally," says Prudential Securities Inc. analyst George Salem.

Now permitted by the Federal Reserve to underwrite both stocks and bonds, Morgan is going head-to-head with Wall Street's investment banking firms and trading houses. J. P. Morgan Securities Inc., the bank's subsidiary, has sprinted from 10th place in 1990to 7th in underwriting U. S. corporate debt, behind such old hands as Merrill Lynch, Goldman Sachs, and the bank's distant cousin, Morgan Stanley. "We may be the new kid on the block," Weatherstone says, "but even considering that, we've done reasonably well."

Morgan has also emerged as a premier trading institution. Attracted by the bank's sterling credit rating and global reach, an increasing number of chief financial officers are turning to Morgan to arrange complex currency and interest-rate swaps. In the third quarter, Morgan's trading revenue jumped 32% from a year ago, to $396 million.

Whether Morgan can build on its recent success over the next few years is far from clear, however. Wall Street will not easily relinquish its turf to interlopers. Nor will the major overseas banks.

'FRUSTRATION.' More fundamentally, competitors claim, Morgan is too staid and conservative. While Morgan executives take pride that they have been able so far to preserve their traditional ways, there is a debate within the bank over whether some changes may be necessary. Morgan Vice-Chairman Roberto G. Mendoza, who heads the bank's mergers-and-acquisitions activity worldwide, confesses to a "frustration." While Morgan's conservative values are winning the bank a lot of business, he acknowledges that the bank is forgoing a lot of other business with smaller, often riskier companies. "We're torn," says Mendoza. "There are more opportunities than our philosophical commitment to quality allows us to do."

The tension between old values and new opportunities has been part of the remaking of Morgan ever since the new strategy was hatched in the early 1980s by Lewis T. Preston, then the bank's imperious chief executive and now president of the World Bank. At the time, Morgan's big clients were turning away from mundane bank loans and instead doing their borrowing in the financial markets. "We had a choice of changing the clients we did business with or changing the institution," recalls Douglas A. "Sandy" Warner III, Morgan's president. Preston decided that Morgan should be able to provide all their clients' financial needs.

In 1985, as the volume of dealmaking began skyrocketing, Preston tapped the Cuban-born, Yale-educated Mendoza, then head of capital markets, to build an M&A team. In accordance with Morgan tradition, the bank decreed that Mendoza should choose most of his staff from within the bank. Morgan has always believed that extensive hiring from the outside can damage its unique cultural fabric. That was even more crucial now, since the bank was facing wrenching structural changes. Morgan loan officers thus were instructed in the art of mergers and acquisitions. Treasury-bond traders learned about underwriting. "I'm a big believer," says Weatherstone, "that there isn't any task we can't handle because of the kinds of people we hire." Mendoza concedes that "we could have made a more immediate impact" if the bank hired from outside. "It was a question of short-term and long-term."

Preserving collegiality has long been a key facet of Morgan's culture. New recruits must complete a 10-week training course that covers everything from capital markets to corporate history. The program is intended to impart a sense of the Morgan mystique, but it also allows young executives to develop an in-house network of contacts. Those connections come in handy, since Morgan professionals are frequently rotated among jobs and country assignments. "You get close to people when you spend upwards of 18 hours a day with them," says Arthur Sculley, head of Morgan's pri-vate bank.

After graduation, the bank works hard to maintain the team atmosphere. Morgan provides a free lunch for staffers in the bank's dining room to

encourage employees to spend time together. New bank officers are invited for informal chats with senior executives, who talk about their experiences at Morgan. Intramural competition, which has led to star systems at other institutions, is actively discouraged. "If you are not part of the team, you will suffer" financially and career-wise, says Walter A. Gubert, the Italian-born executive who heads Morgan's London office.

Morgan's camaraderie, and its strategy to convert itself into a universal bank, were increasingly tested as the Roaring Eighties progressed. Corporate America was slow to call on Morgan for corporate finance work. The bank still had no underwriting capabilities in the U. S., and Morgan's level of expertise was wanting when compared to the likes of Goldman, Sachs & Co.

At the same time, many large commercial banks were prospering. Most lenders booked huge profits on commercial real estate and leveraged buyout lending. Morgan shied away. The bank was shifting resources into trading and the securities business. Moreover, it had learned some bitter lessons from lending to Third World countries, which cost Morgan, and many other big banks, billions. Morgan executives felt real estate and LBOs entailed more risk than they wanted to assume. "We were doing some of those loans," says Weatherstone. But "it was important for us to hold on to our triple-A."

DEFECTIONS. Some Morgan executives, though, became frustrated with the slow pace of progress. "It wasn't easy," says Vice-Chairman Kurt F. Viermetz. "There were big discussions about how long we should wait." Weatherstone acknowledges that there was a lot of soul-searching: "We would always ask ourselves, 'Are we doing the right thing?' The answer was yes."

Ultimately, a few old Morgan hands who disagreed resigned. Others found comfortable niches elsewhere in the bank. "A lot of old-timers went to private banking, where they still talk about the old bank," says one former executive.

Critics outside the bank took pleasure in pointing out that there were few signs Morgan was making any headway. Morgan, though, not only persisted but kept spending lavishly on its strategy. To be more competitive with Wall Street, the bank boosted salaries and bonuses to $1.1 billion in 1989, almost double 1985 levels. Morgan also built a new granite-and-glass headquarters up the block from its former imposing digs at 23 Wall St. The 47-story building, complete with miles of fiber-optic cable and three state-of-the-art trading rooms, was considered a necessary expense. But Wall Street wags, noting the structure's $ 860 million price tag, labeled it Morgan's "Taj Mahal."

The skepticism reached its peak just as Weatherstone took over from the retiring Preston on Jan. 1, 1990. Ten days after he became CEO, Morgan announced a 1989 loss of $1.3 billion, vs. a $1 billion profit in 1988. Much of the red ink stemmed from huge reserves set aside against Third World loans.

As 1990 unfolded, however, everything started to come together for Morgan. While other banks were writing off billions of dollars of bad real estate loans, Morgan was emerging as one of the safest and strongest financial institutions in the world. The AAA rating that it had so tenaciously clung to was solidly intact. Only 2.5% of Morgan's loans are nonperforming, vs. 6.6% at other money centers.

Morgan's impeccable balance sheet has became a key competitive lure to corporations and governments. In Latin America, Morgan has become the clear leader in M&A. "They own the market," says one competing banker. "Of every 10 M&A deals done in Latin America, I wouldn't be surprised if they'd done eight of them."

Morgan is just as dominant a financial force in the Middle East. When it scouted around for loans to rebuild, Kuwait was besieged with offers from 70 banks around the globe. Ahmad Abdul Qader, head of the Kuwait government debt office, says Morgan was chosen because of "pricing, a professional team to manage the transaction, and the high caliber of professionals within the bank." Competitors, however, say Morgan's lofty credit rating gave them an edge. "Their balance sheet played a key role," says a rival who bid for the Kuwait business. He acknowledges that his own institution has "a lot of other baggage. In the current climate, that hurts."

Morgan has also built on historical relationships in Europe. In France, where Morgan's ties go back 125 years, the bank pulled off a coup in June by underwriting a $1.5 billion zero-coupon bond issue for the French government, the first such zero that has ever been issued by France.

GROWING FAST. Morgan is also pushing hard to win more business in Asia. Its recent deals range from advising the Saudi Arabian Oil Co. on its purchase of 35% of Korea's Ssang Yong Oil Refining Co. to helping Sony Corp. acquire a 310,000-square-foot plot of land near the Berlin Wall for Sony's European headquarters. Morgan has assembled a task force to prospect for opportunities in more difficult Asian markets, such as China.

Now that it has won securities powers in the U. S., Morgan is quickly expanding its activities at home. In 1989, Morgan was one of a dozen U. S. banks allowed by the Federal Reserve to underwrite corporate debt issues. To exploit this, Morgan once again has assembled a homegrown underwriting team, drawing on its experienced hands in London. Says Ramon de Oliveira, head of Morgan's high-yield debt and equity underwriting business: "We're not completely new babes in the wood."

Morgan has been quite successful in attracting underwriting business from its large roster of blue-chip clients for whom it has long provided commercial banking services. The list includes the cream of Corporate America, such as PepsiCo Inc. and Procter & Gamble Co. "We've had a connection with Morgan for over 30 years. We know them, and they know us," says Arnold Henson, chief financial officer for American Brands Inc. American Brands hired Morgan to lead a $200 million bond issue last September. It was one of the few times that Morgan Stanley has not led an issue for the tobacco and liquor producer.

Translating these deals into huge profits has been more of a problem. Although catering mostly to big, affluent companies commands a lot of attention, making deals with smaller, often riskier companies produces bigger profit margins. "The high-rated market is a little more peaceful," says one banker. "It looks good on a tombstone, but it doesn't generate much money." Morgan, further, has had trouble breaking into equity underwriting, which the bank was granted permission to do in September, 1990. Many chief financial officers believe Morgan is too green. Although it has participated in 46 underwritings, Morgan has yet to lead a deal. Colgate-Palmolive Co. Treasurer Brian J. Heidtke, whose company included Morgan in an underwriting syndicate for a $460 million equity offering in November, doesn't put Morgan in the league of a Goldman or Merrill yet. "It's a matter of experience and track record," he says.

Sales is another weakness. Morgan's ability to place a stock issue internationally is unparalleled, but CFOs say its domestic capability is relatively weak. "They didn't know the buyers as well," says Richard F. Pops, president of Alkermes, a Cambridge (Mass.) biotechnology firm. Morgan co-managed an $18 million equity offering for Alkermes last July. Though he was pleased with Morgan's work, Pops points out that the bank had no "recognized analyst" to track the stock and maintain interest.

Morgan's investment banking activities, in fact, have played only a small role in the bank's recent bountiful profits. The incredible third-quarter results, say analysts, derived in large part from the precipitous decline in interest rates. Not only did the steep yield curve create a volatile trading environment, but it also greatly lowered Morgan's cost of funds. Unlike other banks, which depend on deposits for funds, Morgan borrows short-term money from the market and then lends long-term. When rates decline, the spread creates a windfall for the bank. Its net interest revenues rose 26%, to $392 million. But corporate finance fees slipped 10%, to $52 million. Morgan doesn't disclose underwriting fees.

Still, Morgan's steady advance has begun to worry Wall Street. At a time when the volume of corporate finance work is down, Morgan's gains are coming at the expense of established firms. And many are crying foul. They argue that Morgan can raise funds more cheaply in the marketplace because, as a commercial bank, it can readily borrow from the Fed if it runs into trouble.

Some Wall Streeters have even alleged that Morgan, as well as such other banks as Bankers Trust, uses strong-arm tactics to win business. In September, John S. Tamagni, chairman of the Securit from certain banks, a corporation must hire the banks for corporate finance work. In the past, the SIA has lobbied for legislation that would have restrained the ability of banks to lend and underwrite at the same time.

The real barriers to Morgan's future progress are likely to be cultural, not legislative. There are many signs that the bank is taking a much more venturesome and imaginative approach to getting new business. A 10-person group, for instance, is seeking to expand its business with midsize companies.

A STEADY PACE. Even Morgan's private bank, once considered the last vestige of the Old Morgan, is showing a new competitive vigor. No longer content with serving just blue-blood families, the bank is actively going after the nouveaux riches. It has opened offices in California and Florida as well as in such overseas cities as Milan and Madrid. Still, Morgan's minimum requirement of clients is $5 million. Since 1987, the private bank has doubled assets under management to $22.6 billion. Sculley hopes to maintain the same pace of growth over the next five years.

Morgan's management under Weatherstone is also showing unusual flexibility in plotting the bank's future. Morgan has even been willing to consider a merger, which would have been unthinkable a few years ago. "We've run the numbers on all the major banks where we thought a merger would offer some potential," says Weatherstone, without identifying any institution. So far, however, Morgan has decided to go it alone. "Nothing makes sense at this point," Weatherstone says. But he adds that "we remain open-minded." Chase Manhattan Corp. was one of the banks Morgan studied earlier this year, according to banking sources. Chase's upscale corporate business was seen as a clean fit with Morgan's. Moreover, the sources say, some executives at Morgan were intrigued by Chase's retail business, whose deposits could have provided a source of funds to guard against an upturn in rates. But other executives rebelled at the notion of getting into retail banking, which is alien to Morgan's other operations.

Despite these indications that Morgan is willing to at least tinker with J. P.'s legacy, critics claim that ultimately the bank's ingrained conservatism, its fundamental aversion to risk, will limit its ability to be a major financial player as the 1990s evolve. Weatherstone disagrees. He argues that after the excess of the 1980s, plenty of clients will want to deal with a firm like Morgan. "Yes, we are conservative, and we do have a set of values, and that should scare competitors," he argues. "We're not street fighters, but we have a lot of very competitive people here." Above all, he insists that his bank's core values won't have to change. In the intensely competitive 1990s, the perpetuation of J. P.'s august legacy will hinge on whether Weatherstone is right.MORGAN'S FLURRY OF INTERNATIONAL DEALS